Whole Foods Buyout, Prime Day Drive Amazon (AMZN) Q3 Earnings

Amazon.com AMZN delivered a massive beat in its third-quarter 2017 results. Earnings per share of 52 cents beat the Zacks Consensus Estimate by 51 cents and were up 30% sequentially. Earnings were however flat year over year.

Revenues of $43.7 billion beat the consensus mark by $1.6 billion and were up 15.3% sequentially and 33.7% year over year. Revenues also came well ahead of the guided range of $39.25-$41.75 billion.

Amazon shares rallied an impressive 7.6% in afterhours trading in response to the huge earnings beat. Year to date, shares have gained 29.7%, underperforming the industry ‘s rally of 46.9%.

Both product and service sales were up sequentially and year over year. Service sales grew a lot stronger than product sales on a year-over-year basis (up 44.3% compared with product sales growth of 28.8%). Revenue distribution between the two was 66%/34%.

The North America segment accounted for around 58% of sales, representing a sequential increase of 13.8% and a year-over-year increase of 34.8%. The International segment accounted for 31%, up 19.4% sequentially and 29.3% year over year.

The AWS segment was up 11.8% sequentially and a massive 41.9% year over year with revenue share at nearly 10%.

Gross Margin

Gross margin was down 119 basis points (bps) sequentially but up 201 bps year over year to 37%. Sequential variations in gross margin were largely mix-related. Growth in AWS had a positive impact on margin. Pricing was also an important factor, given the increase in product categories all over the world and Amazon’s strategy of heavily discounting products and services while building position in any market.

Gross profit dollars were up 40.9% from last year. The consistent year-over-rise in gross profit dollars reflects the success of Amazon’s strategy.

Operating Performance

Amazon’s operating expenses of $15.8 billion were up 14.2% sequentially and 45.7% from the year-ago quarter. Amazon’s heavy investing activities (headcount, fulfillment centers, TV shows and movies, AWS, acquisitions, India expansion and what not) over the past few quarters have increased its costs. Cost of goods sold increased 119 bps sequentially as a percentage of sales with marketing expense decreasing 21 bps, technology and content decreasing 103 bps and general and administrative expense decreasing just 10 bps.

The net result was an operating margin of 0.8%, down 86 bps sequentially and 96 bps from the year-ago quarter. Amazon reported an operating profit of $347 million compared with $628 million in the previous quarter and $575 million in the year-ago quarter.

Net Income

Amazon generated third-quarter net income of $156 million, or 0.6% of sales, compared with $197 million, or 0.5% in the previous quarter and $252 million, or 0.8% of sales in the same quarter last year. Net income was up 30% sequentially and 1.6% year over year. There were no one-time items in the third quarter. Therefore, GAAP EPS was same as pro forma EPS of 52 cents compared with 40 cents in the previous quarter and 52 cents in the year-ago quarter.

Balance Sheet and Cash Flow

Amazon ended the quarter with cash, cash equivalents and marketable securities balance of almost $ 24.3 billion, up from $21.45 billion in the prior quarter.

The company generated $3.9 billion of cash from operations, spending $2.7 billion on fixed assets (including internal-use software and website development costs) and $13.2 billion on acquisitions. Principal repayments of capital lease obligations were $1.3 billion in the third quarter.

Guidance

Management provided guidance for the fourth quarter of 2017. Revenues are expected to include a 1000 bps impact to Amazon’s year-over-year growth rate from Whole Foods Market and $1.2 billion or 270 bps positive FX impact and come in around $56.0-60.5 billion. The mid-point of the guided range is slightly lower than the Zacks Consensus Estimate of $58.93 billion. Operating income is expected to come in at approximately $300 million-$1.65 billion.

Some Analysis

Amazon keeps its retail business very hard to beat on price, choice, and convenience with the help of a solid loyalty system in Prime and its FBA strategy. The company continues to push advantages exclusively to Prime members, thus encouraging them to spend more on Amazon. The company has been expanding Prime internationally to strengthen its foothold in international markets and create a launch pad for its other business.

AWS continues to be the cash cow for Amazon. It has millions of customers and generates much higher margins than retail. It is the key driver of Amazon’s profitability. AWS is gaining momentum with customers including Adobe, GE Oil & Gas, Kellogg’s, Airbnb, hilips, Pinterest, Spotify, Tata Motors, Unilever, McDonalds, BMW, British Gas, Capital One, US Department of State and USDA Food and Nutrition Service. Amazon remains the cloud infrastructure leader, well ahead of the likes of IBM Corp. IBM and Alphabet GOOGL .

In the third quarter, Amazon made available VMware Cloud on AWS, a move that enables users to run VMware vSphere-based public, private, and hybrid cloud platforms on the Amazon cloud apart from internal servers. AWS and Microsoft partnered to launch an open source deep learning library called Gluon that enables developers to prototype, develop, train, and deploy machine learning models for the cloud, and mobile apps.

We remain optimistic about the functionality, partner ecosystem and the experience AWS offers and believe this will lead to continued customer wins. If AWS continues to witness the same kind of success, investors can hope for significant growth going forward.

Alexa powered Echo devices are going great guns and help the company sell products and services. Alexa has already been integrated into a host of everyday devices for the digital home and there are agreements for more. Currently, Alexa is equipped with more than 25,000 of skills and can connect to any stream of business.

In the third quarter, Amazon and Microsoft partnered to allow their respective digital voice assistants, Alexa and Cortana, to communicate with each other and access their individual features. Amazon is racing to build an ecosystem around Alexa to make sure that it stays well way ahead of Google’s smart assistant and Apple’s AAPL Siri.

Amazon has intensified its grocery push as evident from the acquisition of leading natural and organic foods supermarket, Whole Foods Market for $13.7 billion. The acquisition has contributed $1.3 billion to sales and $21 million to operating income in the third quarter. Through this acquisition, the company is targeting the considerably large customer base that still prefers to shop at physical stores. This is Amazon’s way of tackling mounting competition and slow growth in the e-commerce space.

Currently, Amazon carries a Zacks Rank #4 (Sell).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here .

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